Tax-free allowances
With taxes at their highest since World War II, it’s essential to understand the impact of tax-free allowances and frozen tax thresholds on your tax liability. With frozen tax thresholds pushing more people into higher tax bands, it’s important to make the most of any tax allowances available to help you minimise your tax liability.
Frozen tax thresholds
The tax threshold for basic rate taxpayers is currently £50,270 a year or £4,189 per month. Income below this amount is taxed at 20% while anything you earn above this amount falls into the higher rate tax band and is taxed at 40%. The threshold has been frozen since 2021/22 and will remain so until 2031/32.
This prolonged freeze means that as wages rise with inflation, more people are being pushed into the higher rate tax bracket – a phenomenon known as “fiscal drag” – resulting in significantly increased tax revenues for the government without actually changing the tax rates themselves. It’s a sneaky way of increasing tax without actually raising the percentage tax rate.
Inflation and tax thresholds
If the basic rate tax threshold had increased in line with inflation, it would be around £62,000 a year now. To illustrate the impact of the threshold freeze, if you were earning £50,000 a year in 2021 and received annual inflationary increases, you’d be earning around £61,000 today. In 2021, you would have paid £7,540 in tax, which is an effective tax rate of 15% of your pay. With an income of £61,000, currently you will pay £11,832 in tax, which is an effective tax rate of 19.4%. Had the basic rate threshold increased with inflation, you would have remained a basic rate taxpayer with a consistent effective tax rate of 15%. The frozen threshold means that £10,730 of your income now falls in the higher rate tax band and is taxed at 40%.
Money you can earn tax-free
The government has been decreasing the tax-free allowances on various income sources over the last few years, slowly squeezing more tax out of us. Fortunately, there are still some tax-free allowances that can benefit us, and a few that do still increase annually with inflation. Below are details of some of the tax allowances:
Personal allowance
The personal allowance is currently £12,570 per year and is available to all UK taxpayers, which lets you earn up to this amount annually tax-free. This means the first £12,570 of your annual income is tax-free, with income exceeding the allowance subject to tax. Some people will have an adjusted personal allowance if they have overpaid or underpaid tax in a previous year. Your personal allowance is determined by your tax code, which is 1257L if you receive the full allowance of £12,570.
Personal savings allowance
Basic rate taxpayers, or those with annual income up to £50,270, can earn £1,000 in savings interest tax-free. If you’re a higher-rate taxpayer, the allowance is £500, while additional-rate taxpayers don’t receive any allowance.
Starting rate savings allowance
The starting rate allowance of £5,000 benefits individuals who have a low income but significant savings interest. If your annual income, excluding any savings interest income, is less than £12,570, you may be entitled to the full starting rate savings allowance of £5,000. Adding this to your personal allowance lets you earn a combined income plus interest of up to £17,570 per year tax-free. You may also be able to claim the extra £1,000 personal savings allowance.
For every £1 of other income (or non-savings income) that you earn over £12,570, the starting rate allowance reduces by £1. For example, if your salary is £14,000, your starting rate allowance will reduce to £3,570.
Trading allowance
The trading allowance is great if you have a small side hustle, as it lets you earn up to £1,000 a year tax-free from self-employed income. Learn more about the rules for claiming the allowance using the links below:
Tax-free allowances on property and trading income – GOV.UK
Property allowance
The annual property allowance of £1,000 is available to deduct from property income. You can deduct either the allowance or allowable property expenses from property income, but not both. If your allowable expenses are less than £1,000 for the tax year, then it is more tax efficient to deduct the £1,000 property allowance.
Dividend allowance
The annual dividend allowance lets you earn up to £500 of dividends from investments. Any dividend income above this is taxed at 8.75% for basic rate taxpayers, increasing to 10.75% from April 2026.
Capital gains allowance
The first £3,000 of annual capital gains are tax-free. These can be gains made from selling assets such as stock market shares (outside of an ISA), selling artwork, property, etc. Any amounts exceeding the allowance are taxed at 20% for basic rate taxpayers and 24% for higher rate taxpayers.
Rent a room scheme
The rent a room scheme lets you earn up to £7,500 a year tax-free from renting out a furnished room in your home. You can learn more from HMRC’s site, using the link below:
Rent a room in your home: The Rent a Room Scheme – GOV.UK
Married allowance
The married allowance lets you transfer up to £1,260 of your personal allowance to your spouse or civil partner, saving you up to £252 a year in tax. This is particularly useful if one partner isn’t working or is working part-time and earning less than £12,570.
Tax rates on income
Different sources of income have varying tax rates, which can be subject to change. The table below illustrates the current tax rates and future rate increases. Tax is payable at these rates on any income received in excess of the tax-free allowances.
| Income type | Current tax rates | Future rates |
|---|---|---|
| Dividends: | from April 2026: | |
| Basic rate | 8.75% | 10.75% |
| Higher rate | 33.75% | 35.75% |
| Additional rate | 39.35% | 39.35% |
| Capital gains: | ||
| Basic rate | 20% | |
| Higher rate | 24% | |
| Savings interest & property income: | from April 2027: | |
| Basic rate | 20% | 22% |
| Higher rate | 40% | 42% |
| Additional rate | 45% | 47% |
Structuring your income and utilising the available tax-free allowances can help you reduce the amount of income tax you pay. You should also make use of ISAs that let you save and invest tax-free, so you keep any interest, dividends and capital gains in full. The links below provide more information about the various tax allowances.
HMRC resources:
Marriage Allowance: How it works – GOV.UK
Tax on savings interest: How much tax you pay – GOV.UK
Blind Person’s Allowance: Overview – GOV.UK
Tax-free allowances on property and trading income – GOV.UK
Tax on dividends: Check if you have to pay tax on dividends – GOV.UK
Capital Gains Tax: what you pay it on, rates and allowances: Capital Gains Tax allowances – GOV.UK
